Pimco's El-Erian: Ugh, Recession Is Now More Likely

Mohamed El-Erian, CEO & CO-CIO, Pimco

Friday, 21 Dec 2012 | 10:58 AM ETCNBC.com

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Colin Anderson | Photographer's Choice | Getty Images

Here is a simple way to think about the political calculus of Washington's latest twists and turns. And — unfortunately — it suggests that economic and market dislocations may be needed to get our politicians to cooperate and govern properly.

Hoping to resolve this problem and thus deliver consensus, party leaders opted in the summer of 2011 for a very big stick: threaten the country with a major economic setback as a way to get the rank and file of both parties to cooperate.

This, of course, was the strategic underpinning of the fiscal cliff: By designing large and blunt spending cuts and tax hikes that would automatically go into effect, and thus push the country into a costly recession, political leaders hoped to impose compromise among bickering and dithering politicians — particularly among those with very different views of the past, present and future. (Read More: Fiscal Cliff, Complete Coverage)

The stick succeeded in catalyzing serious negotiations between President Obama and House Speaker Boehner. But the stick was not big enough to overcome differences and force a cooperative outcome. And with Republicans facing the bigger risk of being blamed by the country for the failure, Speaker Boehner opted for his Plan B.

Now the situation has taken an even more interesting turn.

The Speaker's inability Thursday to unite Republicans behind his plan highlights the extent to which mutual trust is also seriously lacking WITHIN the political parties — and not just between them. This meaningfully complicates the cooperative solution. (Read More: Boehner Abruptly Scraps 'Plan B' Vote in Setback)

How about the future?

Let us start with the obvious. In order to avoid a recession that would aggravate the country's unemployment problem and reignite concerns about housing and household finances, Democrats and Republicans need quickly to find a way to work together. While possible, it is hard to see how this happens endogenously. There are lots of divisions, and at many levels.

If an internal resolution mechanism is indeed lacking, than cooperation will need to be forced by an outside event. This is where economic and market volatility comes in.

Thursday's collapse of Speaker Boehner's Plan B unfortunately makes it more likely that the fiscal cliff may materialize, constituting a blow to a recovering US economy. Absent some last minute messy deal that buys a few weeks at best, that would constitute stage one.

The question about stage two is how much time do political parties then need to find a solution and avoid a bigger economic and financial implosion.

The 2008 experience with TARP — where the market and economic dislocations that followed the initial congressional vote rejection quickly forced politicians to cooperate — suggests that there is nothing like visible turmoil to get our bickering political parties to come together properly in the national interest.

Let us hope that the political system responds in a similar fashion in the coming weeks, if not earlier. There is a lot at stake.

Mohamed El-Erian is the CEO and Co-CIO of Pimco, which oversees nearly $1.8 trillion in assets and runs the Pimco Total Return Fund, the largest bond fund in the world. His book, "When Markets Collide," was a New York Times and Wall Street Journal bestseller, won the Financial Times/Goldman Sachs 2008 Business Book of the Year and was named a book of the year by The Economist and one of the best business books of all time by the Independent (UK).